Oil Companies Show Faith in Natural Gas

Natural gas has been down in the dumps for so long that it’s hard to make a bullish case for it without sounding a little desperate. It burns clean! The gas-to-oil price ratio is absurdly low! There are plans to convert the U.S. trucking fleet to natural gas – that’s a whole new market!

You’ve probably heard it all before. Yet, even with Japan’s nuclear crisis making all non-nuclear energy sources look particularly attractive right now, the price of gas is still about 70 per cent below its 2008 high and continues to hug its depressed two-year trading range.

But natural gas assets are another story, and the recent appetite for them suggests that investors should give natural gas companies a second look.

KPMG recently pointed out that unconventional natural gas resources were the biggest source of mergers and acquisitions activity in the North American energy market over the past three years. In 2010, Chevron Corp. (NYSE:CVX) bought Atlas Energy Inc. for $5.5-billion (U.S.). Exxon-Mobil Corp. (NYSE:XOM) bought XTO Energy Inc. for $31-billion. And France’s Total SA invested $2.3-billion in Chesapeake Energy Corp.(NYSE:CHK)

The frenzy of activity has driven share prices of other natural gas producers higher. Just look at Encana Corp. (NYSE:ECA) [[entity]]Encana Corp. [[/entity]]ECA-T Although the price of natural gas is down 5.5 per cent in 2011, Encana shares are up nearly 18 per cent over the same period, after factoring in dividends.

In other words, a lowly natural gas producer has outperformed the S&P/TSX composite index by a factor of five this year, and has also beaten the returns on oil producers Suncor Energy Inc. (NYSE:SU), Talisman Energy Inc. (NYSE:TLM), Chevron and Exxon, even as oil has surged above $100 (U.S.) a barrel.

There could be more gains ahead for Encana, and others. With oil companies spending billions of dollars on natural-gas-related acquisitions, they clearly see a big payoff down the road, either through higher natural gas demand or lower supply.

While some M&A moves can look like money wasters, these ones coincide with cheap gas – and that looks intriguing bullish.